You may need the charts from the original article to follow the author's technical
analysis.
http://www.clifdroke.com/articles/jan10/101810/011810.html
18th January 2010
by Clif Droke
Many have wondered why the 10-year cycle peak in late September/early
October didn’t produce a more meaningful correction in the broad
market. Instead, the 10-year cycle peak produced only a marginal six
percent pullback in the S&P 500 Index (SPX) instead of the much deeper
one usually associated with the 10-year peak.
A look at the past reveals why: the first full year following a crash
low has never produced a sizable correction in the stock market. That
historical truism certainly proved itself out in 2009. But what of the
second year after a crash? What can we expect in the coming year based
on market history? We’ll be taking up this question in the commentary
that follows.
The two most persistent traits that investors displayed in 2009 were
either the avoidance of the stock market altogether by remaining in the
safety of cash or else to look for opportunities to sell short each
time the market took so much as a breather. Both of these tendencies
were direct consequences of the historic credit crisis of 2008. It
has long been observed that retail investors typically shy away from
equities for at least the first two years following a major bear market
or stock market crash. The painful memories take time to heal and leave
deep and abiding scars.
Even for those stalwarts who stay the course and continue trading and
investing, a market crash creates a tendency toward conservatism. Traders
tighten up protective stops on all their trades, avoid over-trading,
refuse to buy large positions in any one stock and make a serious
effort at avoiding the mistakes that were made during the heady days
of the forgiving bull market. Indeed, the reversion to conservatism
and self-examination among market participants is one of the redeeming
qualities of a market crash. Bear markets are purgative in that they
cleanse the system of lavish excesses and restore a sense of propriety
to the market by and large.
For those investors who respond to the destruction wrought by a crash by
refusing to participate, the resulting effect is equally beneficial to
the overall soundness of the market. These non-participants, who comprise
the great majority of all potential retail investors, will spend the
next year building cash reserves and restoring their personal balance
sheets. While this won’t necessarily be of any benefit to the stock
market, nor to those who make their living in the brokerage or advisory
business, it will act as a reserve – or liquidity bank if you will –
for the future. For at some point the market will need this liquidity
and by the time those reserves are needed, the painful memories of the
previous bear market will have dissolved from the public’s collective
memory. As their confidence grows they will become more enticed by the
lure of the potential returns of stocks vis-à-vis the low-yielding
safety of the bond market.
Returning to our original observation concerning market behavior in
the 1-2 years following a crash, let’s examine some chart examples of
the past few bear markets. Perhaps the single best example and the one
that most closely correlates to our time is the crash of 1973-74. This
particular bear market was a function of the Kress 40-year cycle,
which bottomed in October 1974. It produced a painful and persistent
decline in the S&P 500 for the better part of two years, as well as
an economic recession. At the time this happened it was the worst bear
market stocks had suffered since the Great Depression. By the time it
ended the SPX had lost some 45% of its value. As you can well imagine
(and some of you may actually remember it), the feeling at the bottom
in October ‘74 was one of unmitigated doom and gloom – a feeling
that persisted in the public’s mind well beyond 1974.
The market was anything but forlorn in the two years following this bear
market. In the year 1975 the stock market rallied vigorously and with
relatively mild corrections along the way. The Dow Jones Industrial
Average (DJIA) rallied 100 percent in ’75, a record performance
following a bear market and one that stands to this day. The market
continued its recovery into 1976, and although its ’76 performance
wasn’t anywhere near as stellar as the one in ’75 it remains immune
to major corrections and kept the recovery going for two full years
following the bear market low in 1974.
Of course the market cycles which comprised the 1973-74 bear market
were considerably different than the cycles underlying the 2007-08 bear
market. Yet the market dynamics between the two eras are so remarkably
similar that the inference can still be drawn that ours is a situation
analogous to the 1975-76 recovery.
Notice in the above chart of the Dow that the 1976 follow-up to the
explosive 1975 rally was much more volatile and less dynamic, yet it was
still a positive year overall for the Dow. The possibility exists that
2010 could end up being a positive year overall in spite of the 4-year
cycle bottoming later this year. The inference that can definitely be
made is that the coming year will almost certainly show more bumpiness
than 2009 and less dynamic market action.
If 1976 holds any clues for how 2010 will play out then we can expect
more range-bound behavior from the major indices. This means stock
selection will become more important as the sectors showing only the
best relative strength, forward momentum and earnings growth should be
favored over weaker sectors. The coming year is likely to reward good
stock selection as opposed to the “buy with both hands” strategy
that played out so well in 2009. Market timing will also be more critical
in 2010 as opposed to last year since there are two major cycle bottoms
scheduled this year: one in the first quarter of the year and one around
late September/early October (namely the 4-year cycle).
The next example in our survey of bear markets is the bear market
of 1981-82. From the depths of this bear was spawned an apocalyptic
sentiment made infamous by several high-profile movies with Armageddon
type themes in the early ‘80s. While the ’81-’82 bear market
wasn’t as severe as the previous one of ’73-74, it was strong
enough to exert a profound influence on investor psychology and left
the retail investment crowd with a revulsion toward equities for the
next 2-3 years. It also launched the powerful ‘80s bull market,
which didn’t meet its apogee until the end of the decade.
Let’s turn our attention specifically to the 1-2 years following the
’81-’82 bear market. As you can see in the following chart example,
the first full year following the bear market low saw no major correction
in the SPX. Even 1984, which saw considerably more volatility than ’83
due to the bottoming 10-year and 30-year cycles, wasn’t as bad a year
as it probably should have been.
This is significant for several reasons. Consider that 1984 by all
indications should have been a bearish year, yet it wasn’t that
bad for stocks in the overall scheme in spite of the fact that a
major long-term Kress cycle was bottoming. The reason for this was
because the public was still scared to the point of non-participation
and the lingering abhorrence to equities following the bear market
from two years prior was still a major factor. This can’t be is
emphasized enough. As ephemeral as crowd psychology can be, when the
retail investor is paralyzed with fear and revulsion toward stocks,
the market enjoys a strong support regardless of the cycles that may
be leaning against stocks as long as tight money conditions aren’t
prevalent. At extremes, negative crowd psychology is strong enough to
contend even with the cyclical forces of the stock market up to a point,
analysis.
http://www.clifdroke.com/articles/jan10/101810/011810.html
18th January 2010
by Clif Droke
Many have wondered why the 10-year cycle peak in late September/early
October didn’t produce a more meaningful correction in the broad
market. Instead, the 10-year cycle peak produced only a marginal six
percent pullback in the S&P 500 Index (SPX) instead of the much deeper
one usually associated with the 10-year peak.
A look at the past reveals why: the first full year following a crash
low has never produced a sizable correction in the stock market. That
historical truism certainly proved itself out in 2009. But what of the
second year after a crash? What can we expect in the coming year based
on market history? We’ll be taking up this question in the commentary
that follows.
The two most persistent traits that investors displayed in 2009 were
either the avoidance of the stock market altogether by remaining in the
safety of cash or else to look for opportunities to sell short each
time the market took so much as a breather. Both of these tendencies
were direct consequences of the historic credit crisis of 2008. It
has long been observed that retail investors typically shy away from
equities for at least the first two years following a major bear market
or stock market crash. The painful memories take time to heal and leave
deep and abiding scars.
Even for those stalwarts who stay the course and continue trading and
investing, a market crash creates a tendency toward conservatism. Traders
tighten up protective stops on all their trades, avoid over-trading,
refuse to buy large positions in any one stock and make a serious
effort at avoiding the mistakes that were made during the heady days
of the forgiving bull market. Indeed, the reversion to conservatism
and self-examination among market participants is one of the redeeming
qualities of a market crash. Bear markets are purgative in that they
cleanse the system of lavish excesses and restore a sense of propriety
to the market by and large.
For those investors who respond to the destruction wrought by a crash by
refusing to participate, the resulting effect is equally beneficial to
the overall soundness of the market. These non-participants, who comprise
the great majority of all potential retail investors, will spend the
next year building cash reserves and restoring their personal balance
sheets. While this won’t necessarily be of any benefit to the stock
market, nor to those who make their living in the brokerage or advisory
business, it will act as a reserve – or liquidity bank if you will –
for the future. For at some point the market will need this liquidity
and by the time those reserves are needed, the painful memories of the
previous bear market will have dissolved from the public’s collective
memory. As their confidence grows they will become more enticed by the
lure of the potential returns of stocks vis-à-vis the low-yielding
safety of the bond market.
Returning to our original observation concerning market behavior in
the 1-2 years following a crash, let’s examine some chart examples of
the past few bear markets. Perhaps the single best example and the one
that most closely correlates to our time is the crash of 1973-74. This
particular bear market was a function of the Kress 40-year cycle,
which bottomed in October 1974. It produced a painful and persistent
decline in the S&P 500 for the better part of two years, as well as
an economic recession. At the time this happened it was the worst bear
market stocks had suffered since the Great Depression. By the time it
ended the SPX had lost some 45% of its value. As you can well imagine
(and some of you may actually remember it), the feeling at the bottom
in October ‘74 was one of unmitigated doom and gloom – a feeling
that persisted in the public’s mind well beyond 1974.
The market was anything but forlorn in the two years following this bear
market. In the year 1975 the stock market rallied vigorously and with
relatively mild corrections along the way. The Dow Jones Industrial
Average (DJIA) rallied 100 percent in ’75, a record performance
following a bear market and one that stands to this day. The market
continued its recovery into 1976, and although its ’76 performance
wasn’t anywhere near as stellar as the one in ’75 it remains immune
to major corrections and kept the recovery going for two full years
following the bear market low in 1974.
Of course the market cycles which comprised the 1973-74 bear market
were considerably different than the cycles underlying the 2007-08 bear
market. Yet the market dynamics between the two eras are so remarkably
similar that the inference can still be drawn that ours is a situation
analogous to the 1975-76 recovery.
Notice in the above chart of the Dow that the 1976 follow-up to the
explosive 1975 rally was much more volatile and less dynamic, yet it was
still a positive year overall for the Dow. The possibility exists that
2010 could end up being a positive year overall in spite of the 4-year
cycle bottoming later this year. The inference that can definitely be
made is that the coming year will almost certainly show more bumpiness
than 2009 and less dynamic market action.
If 1976 holds any clues for how 2010 will play out then we can expect
more range-bound behavior from the major indices. This means stock
selection will become more important as the sectors showing only the
best relative strength, forward momentum and earnings growth should be
favored over weaker sectors. The coming year is likely to reward good
stock selection as opposed to the “buy with both hands” strategy
that played out so well in 2009. Market timing will also be more critical
in 2010 as opposed to last year since there are two major cycle bottoms
scheduled this year: one in the first quarter of the year and one around
late September/early October (namely the 4-year cycle).
The next example in our survey of bear markets is the bear market
of 1981-82. From the depths of this bear was spawned an apocalyptic
sentiment made infamous by several high-profile movies with Armageddon
type themes in the early ‘80s. While the ’81-’82 bear market
wasn’t as severe as the previous one of ’73-74, it was strong
enough to exert a profound influence on investor psychology and left
the retail investment crowd with a revulsion toward equities for the
next 2-3 years. It also launched the powerful ‘80s bull market,
which didn’t meet its apogee until the end of the decade.
Let’s turn our attention specifically to the 1-2 years following the
’81-’82 bear market. As you can see in the following chart example,
the first full year following the bear market low saw no major correction
in the SPX. Even 1984, which saw considerably more volatility than ’83
due to the bottoming 10-year and 30-year cycles, wasn’t as bad a year
as it probably should have been.
This is significant for several reasons. Consider that 1984 by all
indications should have been a bearish year, yet it wasn’t that
bad for stocks in the overall scheme in spite of the fact that a
major long-term Kress cycle was bottoming. The reason for this was
because the public was still scared to the point of non-participation
and the lingering abhorrence to equities following the bear market
from two years prior was still a major factor. This can’t be is
emphasized enough. As ephemeral as crowd psychology can be, when the
retail investor is paralyzed with fear and revulsion toward stocks,
the market enjoys a strong support regardless of the cycles that may
be leaning against stocks as long as tight money conditions aren’t
prevalent. At extremes, negative crowd psychology is strong enough to
contend even with the cyclical forces of the stock market up to a point,
